Growth investors are always on the lookout for ways to improve their odds and increase their gains. And stories taken from sports are a great place to look for insight into investing basics. Here’s one of my favorites.
I have a friend who’s an avid tennis player, the kind of guy who routinely finishes high in his club championships and sometimes wins. But he has always believed that with just a little help from a top tennis coach he could be a truly great player.
Years ago, he attended the U.S. Open Tennis Tournament in New York and got a great seat at one of the quarterfinal matches—Andy Roddick versus Joachim Johansson—in the second row behind the end line. He realized that he was sitting two seats away from Roddick’s coach (and brother), John Roddick. This, he realized, might be his chance to overhear the kind of advice a top coach might give to a top player.
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And he did.
After Roddick lost the first two sets, his brother screamed at him during the changeover, “Keep your eye on the ball!” Roddick eventually lost the match to Johansson, but not before coming back to even the match at two sets apiece.
The lesson? Even at the highest levels, the most basic things are still the most important. If you’re looking for some inside trick that great investors use to make more money than the rest of us, you’re probably wasting your time. There’s a reason that the basics are the basics.
But if you want my opinion on the most important rule of investing basics, the one that’s the equivalent of “keep your eye on the ball” for growth investors, I couldn’t pick one … but I could pick three. And here they are.
Investing Basics #1: Follow the Market’s Trend
If you buy when the market is going up, you put the odds on your side, because a bull market changes the odds. It’s always easier to swim with the tide or run with the wind at your back. Stock markets are no different. And when markets are going down, you should work extra hard to weed out your losers and move toward cash for the same reason.
Investing Basics #2: Cut Your Losses Short
When a stock starts falling, you have no idea how far it might go. The only theoretical limit is zero. And the longer you stick with it, the less capital you’ll have to put to work. No matter how much it hurts — and it does hurt, we know from personal experience—you have to admit that you made a mistake and sell the stock when it reaches your sell point. In our advisories, we advise selling when you have a loss of 20% in bull markets and 15% in bear markets. But these are the absolute limits; we often sell at a 5% or 10% loss. Calculate the sell point when you buy the stock, write it down and stick to it. The number of times you get shaken out of a stock that then starts rising again will be more than made up for by the number of times you save your money to fight another day.
Investing Basics #3: Let Your Winners Run
Some investors set buy points as well as sell points. When a stock is showing a 20% profit, or 25% or whatever, they will sell the stock and book the profit. But this approach makes it impossible to enjoy the wealth-building benefit of a stock that doubles and then doubles again, which is how really enormous gains are made. These big gainers, which reward you with compound growth, are what makes aggressive growth investing a winning proposition. It takes just one of them to compensate you for a bunch of stocks that fall short.
There’s a reason that the same old rules are still the rules. Keep it simple. Keep your eye on the ball. And you’ll come up a winner.
Cabot Growth Investor, our flagship advisory, and Cabot Emerging Markets Investor, which I edit, have doubled our readers’ money numerous times by finding market’s strongest stocks and following the rules mentioned above.
Timothy Lutts heads one of America’s most respected independent investment advisory services. Each week, Tim personally picks the single best stock in his exclusive Cabot Stock of the Week advisory. Build your wealth and reduce your risk with the top stock each week for current market conditionsLearn More